A person's credit rating indicates how creditworthy he or she is. In corporate finance, rating usually refers to a "grade" assigned to a bondbond issuer, insurance company or other entity or security to indicate its riskiness.
Securities analysts often issue ratings on stocks; these ratings are usually "Buy," "Sell" or "Hold. The rating system indicates the likelihood that the issuer will default either on interest or capital payments.
For Moody's, the ratings go from Aaa to D, which means the issuer is already in default. Anything below the triple-B rating is considered to be junk, or below investment grade. Bond ratings are periodically revised based on recent data.
Treasury bonds are not rated because they are backed by the "full faith and credit" of the United States government. They are considered to be the safest of investments because the government has the power to levy taxes in order to pay its debts. Why It Matters Ratings have huge influence on the price and demand for certain securities, particularly bonds: The lower the rating, the riskier the investment and the less the investment is worth.
Low ratings often lead to less trading activity and thus liquidity problems. This is why downgrades or rumors of downgrades in an issuer's credit rating can have a significant impact on its securities and on the market or industry. Bonds are not the only securities affected by credit ratings, however.
Preferred stock prices can move sharply when the issuer's credit rating changes as this is an indicator of the issuer's ability to meet preferred dividend obligations. Securities that are convertible into a company's debt are also affected by credit ratings, especially if the convertible security is trading near or above the point at which the holder may convert the security to debt.
Low ratings are not always bad. They simply mean there is more risk associated with an investment and thus more potential for higher returns. In fact, many income investors actively enhance their returns by dividing securities into sectors based on certain characteristics such as credit rating, yieldcoupon, maturity, etc.
Grouping securities by rating is common because investors are trying to rank investments, buy those positioned to improve and sell those expected to decline. An issuer doesn't need to actually default or lose money for an investor to lose money, however -- remember that the simple threat of default or decline can lower the price of the security.IMPORTANT NOTICE.
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